On June 7, 1991, the Spanish Parliament approved a reform of the personal income tax with effect from January 1, 1992. The guidelines of the reform are similar to those implemented in other industrial countries. There is an intention to simplify the tax system (by reducing the number of taxes, rates, and special regimes), to make it as neutral as possible (in the sense of minimizing distortions in resource allocation), and to reduce income tax progressivity. The reform aligns taxation of capital income of residents with the most liberal practices in the EC and eliminates most taxes on capital yields earned by nonresident investors in Spain.
The Rationale for the Reform
Three factors conditioned tax reform in Spain: the need to respond to the February 1989 ruling of the Constitutional Court on income taxation of individuals; the need to adapt the Spanish tax system of financial transactions to EC standards; and the Government’s intention to update tax legislation and tax administration in the light of the experience of the last ten years. Also, the reform tries to address the sharp discrepancy between “nominal” income tax progressivity (defined in terms of the income tax rate schedule) and “effective” tax progressivity (based on actual tax collections). According to the White Paper1 on income tax reform, tax evasion has resulted in important equity problems, with the richest 1 percent of taxpayers contributing about 20 percent of total tax collection. International comparisons of effective tax rates show that rates in Spain are, in general, lower than in other EC countries (Chart 7), despite (or possibly because of) the fact that Spain has one of the highest marginal tax rates in the EC (Table 13).
International Comparisons of Effects Rates for Personal Income Tax, 1987
(By declies of total population)
Source: Spain, Ministry of Economics and Finance.International Comparisons of Effects Rates for Personal Income Tax, 1987
(By declies of total population)
Source: Spain, Ministry of Economics and Finance.International Comparisons of Effects Rates for Personal Income Tax, 1987
(By declies of total population)
Source: Spain, Ministry of Economics and Finance.International Comparison of Marginal Tax Rates for Personal Income Taxation
(In Percent)
International Comparison of Marginal Tax Rates for Personal Income Taxation
(In Percent)
| 1986 | 1988–90 | |||
|---|---|---|---|---|
| Countries | Maximum | Minimum | Maximum | Minimum |
| Spain | 66 | 8 | 56 | 25 |
| United Kingdom | 60 | 29 | 40 | 25 |
| Belgium | 72 | 24 | 55 | 25 |
| Holland | 72 | 16 | 60 | 35 |
| Greece | 63 | 10 | 50 | 18 |
| Italy | 62 | 12 | 50 | 10 |
| France | 65 | 5 | 57 | 5 |
| Denmark | 45 | 20 | 67 | 22 |
| Germany | 56 | 22 | 53 | 19 |
| Ireland | 58 | 35 | 56 | 32 |
| Luxembourg | 57 | 12 | 56 | 10 |
International Comparison of Marginal Tax Rates for Personal Income Taxation
(In Percent)
| 1986 | 1988–90 | |||
|---|---|---|---|---|
| Countries | Maximum | Minimum | Maximum | Minimum |
| Spain | 66 | 8 | 56 | 25 |
| United Kingdom | 60 | 29 | 40 | 25 |
| Belgium | 72 | 24 | 55 | 25 |
| Holland | 72 | 16 | 60 | 35 |
| Greece | 63 | 10 | 50 | 18 |
| Italy | 62 | 12 | 50 | 10 |
| France | 65 | 5 | 57 | 5 |
| Denmark | 45 | 20 | 67 | 22 |
| Germany | 56 | 22 | 53 | 19 |
| Ireland | 58 | 35 | 56 | 32 |
| Luxembourg | 57 | 12 | 56 | 10 |
In February 1989, the Constitutional Court ruled that the personal income tax system, in place since 1978, discriminated in favor of persons living together without being married. This system was a direct personal tax with a single progressive rate schedule. The treatment of the family under this system was the simple aggregation of incomes and joint filing. The 1978 regime was attacked on the grounds that it produced a marriage penalty, because it caused two-income, married couples to pay higher taxes than unmarried couples with the same income. In response to the ruling, the Parliament passed, in July 1989, Law 20/89, which, as a temporary measure, gave family members the option of continuing to obey the previous law by filing a joint tax return or, alternatively, filing separate returns.2 Law 20/89 also considered that a new permanent system would be put in place at the time of the reform of the personal income tax.
In the wake of capital liberalization, Spain needed to respond to prevent the rapid outflow of funds attracted by higher after-tax returns abroad. This “European constraint” called for a revision of the capital income and capital gains tax on residents, which, through 1990, was one of the toughest in the EC owing to the progressivity of the income tax system.
Spain’s own experience with direct taxation is another force for change. In particular, the reform aims at correcting gaps between the spirit of the tax legislation and current tax practices. In principle, Spanish legislation has consistently tried to homogenize the tax treatment of alternative forms of income, to reduce tax arbitrage. In practice, however, there has been a differential tax treatment of different income sources (i.e., double taxation of dividends; special deductions on earned income and rents from housing; restrictions regarding offsetting of capital losses against capital gains, etc.) due to an apparent inertia of special tax regimes that were originally devised for transitory purposes.
At a different level, the tax reform seeks to foster private sector savings. Although the authorities recognize the uncertainties surrounding the relationship between taxation and savings, the reform emphasizes the need to reverse the recent decline in the private savings ratio in Spain.
Main Changes in Tax Legislation
The main areas of change as regards individual income taxation and taxation of capital income are described below.
Individual Income Taxation
The reform broadens the tax base, reduces the progressivity of the income tax, and increases tax deductions for low-income workers. Also, to address the ruling of the Constitutional Court, but at the same time provide the tax system some degree of flexibility, two optional tax rate schedules (one for joint taxation and one for separate taxation) are provided for families (Table 14). In general, the new income tax reduces the tax pressure on families with annual incomes lower than Ptas 2.5 million that choose the joint-filing option.
Income Tax Rate Schedule for 1992
Income Tax Rate Schedule for 1992
| Income Tax Base Up to | Average Tax Rate | Withholding Tax Payment | Rest of Tax Base Up to | Marginal Tax Rate Applied to (4) |
|---|---|---|---|---|
| (1) | (2) | (3) | (4) | (5) |
| Separate Filing | ||||
| (In percent) | (In percent) | |||
| 400.000 | 0.00 | 0 | 600,000 | 20.00 |
| 1.000.000 | 12.00 | 120.000 | 570,000 | 22.00 |
| 1,570,000 | 15.63 | 245,400 | 570,000 | 24.00 |
| 2,140.000 | 17.86 | 382,200 | 570,000 | 26.00 |
| 2.710,000 | 19.57 | 530.400 | 570,000 | 28.00 |
| 3,280,000 | 21.04 | 690.000 | 570,000 | 30.00 |
| 3.850.000 | 22.36 | 861.000 | 570,000 | 32.00 |
| 4,420,000 | 23.60 | 1.043,400 | 570,000 | 34.00 |
| 4,990,000 | 24.79 | 1.237.200 | 570,000 | 36.00 |
| 5,560,000 | 25.94 | 1,442,400 | 570,000 | 38.00 |
| 6,130,000 | 27.06 | 1,659,000 | 570,000 | 40.00 |
| 6,700,000 | 28.16 | 1,887,000 | 570,000 | 42.00 |
| 7,270,000 | 29.25 | 2,126,400 | 570,000 | 44.00 |
| 7,840,000 | 30.32 | 2,377,200 | 570,000 | 46.00 |
| 8,410,000 | 31.38 | 2,639,400 | 570,000 | 48.00 |
| 8,980,000 | 32.44 | 2,913,000 | 570,000 | 50.50 |
| 9,550,000 | 33.52 | 3,200,850 | Thereafter | 53.00 |
| Joint Filing | ||||
| 800,000 | 0.00 | 0 | 1,200,000 | 20.00 |
| 2,000,000 | 12.00 | 240,000 | 625,000 | 24.00 |
| 2,625,000 | 14.86 | 390.000 | 625,000 | 26.00 |
| 3,250,000 | 17.00 | 552,500 | 625,000 | 28.00 |
| 3,875,000 | 18.77 | 727.500 | 625,000 | 30.00 |
| 4,500,000 | 20.33 | 915.000 | 625,000 | 32.00 |
| 5,125,000 | 21.76 | 1.115,000 | 625,000 | 34.00 |
| 5,750,000 | 23.09 | 1.327,500 | 625,000 | 36.00 |
| 6,375,000 | 24.35 | ,552.500 | 625,000 | 38.00 |
| 7,000,000 | 25.57 | ,790.000 | 625,000 | 40.00 |
| 7,625,000 | 26.75 | 2,040,000 | 625,000 | 42.00 |
| 8,250.000 | 27.91 | 2,302,500 | 625,000 | 44.00 |
| 8,875,000 | 29.04 | 2,577.500 | 625,000 | 46.00 |
| 9,500,000 | 30.16 | 2.865,000 | 625,000 | 48.00 |
| 10,125.000 | 31.26 | 3,165,000 | 875,000 | 50.50 |
| 11,000,000 | 32.79 | 3,606,875 | Thereafter | 53.00 |
Income Tax Rate Schedule for 1992
| Income Tax Base Up to | Average Tax Rate | Withholding Tax Payment | Rest of Tax Base Up to | Marginal Tax Rate Applied to (4) |
|---|---|---|---|---|
| (1) | (2) | (3) | (4) | (5) |
| Separate Filing | ||||
| (In percent) | (In percent) | |||
| 400.000 | 0.00 | 0 | 600,000 | 20.00 |
| 1.000.000 | 12.00 | 120.000 | 570,000 | 22.00 |
| 1,570,000 | 15.63 | 245,400 | 570,000 | 24.00 |
| 2,140.000 | 17.86 | 382,200 | 570,000 | 26.00 |
| 2.710,000 | 19.57 | 530.400 | 570,000 | 28.00 |
| 3,280,000 | 21.04 | 690.000 | 570,000 | 30.00 |
| 3.850.000 | 22.36 | 861.000 | 570,000 | 32.00 |
| 4,420,000 | 23.60 | 1.043,400 | 570,000 | 34.00 |
| 4,990,000 | 24.79 | 1.237.200 | 570,000 | 36.00 |
| 5,560,000 | 25.94 | 1,442,400 | 570,000 | 38.00 |
| 6,130,000 | 27.06 | 1,659,000 | 570,000 | 40.00 |
| 6,700,000 | 28.16 | 1,887,000 | 570,000 | 42.00 |
| 7,270,000 | 29.25 | 2,126,400 | 570,000 | 44.00 |
| 7,840,000 | 30.32 | 2,377,200 | 570,000 | 46.00 |
| 8,410,000 | 31.38 | 2,639,400 | 570,000 | 48.00 |
| 8,980,000 | 32.44 | 2,913,000 | 570,000 | 50.50 |
| 9,550,000 | 33.52 | 3,200,850 | Thereafter | 53.00 |
| Joint Filing | ||||
| 800,000 | 0.00 | 0 | 1,200,000 | 20.00 |
| 2,000,000 | 12.00 | 240,000 | 625,000 | 24.00 |
| 2,625,000 | 14.86 | 390.000 | 625,000 | 26.00 |
| 3,250,000 | 17.00 | 552,500 | 625,000 | 28.00 |
| 3,875,000 | 18.77 | 727.500 | 625,000 | 30.00 |
| 4,500,000 | 20.33 | 915.000 | 625,000 | 32.00 |
| 5,125,000 | 21.76 | 1.115,000 | 625,000 | 34.00 |
| 5,750,000 | 23.09 | 1.327,500 | 625,000 | 36.00 |
| 6,375,000 | 24.35 | ,552.500 | 625,000 | 38.00 |
| 7,000,000 | 25.57 | ,790.000 | 625,000 | 40.00 |
| 7,625,000 | 26.75 | 2,040,000 | 625,000 | 42.00 |
| 8,250.000 | 27.91 | 2,302,500 | 625,000 | 44.00 |
| 8,875,000 | 29.04 | 2,577.500 | 625,000 | 46.00 |
| 9,500,000 | 30.16 | 2.865,000 | 625,000 | 48.00 |
| 10,125.000 | 31.26 | 3,165,000 | 875,000 | 50.50 |
| 11,000,000 | 32.79 | 3,606,875 | Thereafter | 53.00 |
To expand the tax base, new sources of income are brought into the definition of taxable income. The case of in-kind benefits provided by enterprises to their executives (i.e., subsidized housing, cars, loans, etc.) is particularly relevant for the reform. These benefits have proliferated in Spain in recent years and have been exempt from taxation. The new legislation adds these benefits to the taxpayer’s monetary income, valuing them at the cost for the enterprise, and applies the corresponding income tax rate. Whenever the provision of these benefits represents no cost to the enterprise (e.g., a house owned by the company) tax liabilities will be based on estimated property values.
Another important effort to broaden the tax base refers to the introduction of new statistical methods to estimate the income of the self-employed. This is particularly important because of the rather low income they declare. According to the White Paper, in 1989, 57 percent of all entrepreneurs filed incomes lower than Ptas 1 million (around $10,000 at current exchange rates) compared with 31 percent of workers. To address the problem, the Government is now trying to improve the coordination between income and corporate taxation. Also, new statistical methods (presumptive indicators based on “representative” taxpayers called Estimatión Objetiva Singular por Indices o (Módulos) are being devised to estimate these sources of income.
To reduce the progressivity of the income tax system, the new legislation reduces the top marginal rate from its current level of 56 percent to 53 percent in 1992 and to 50 percent in 1993. At the same time, the lowest marginal tax rate is reduced from 25 percent in 1991 to 20 percent in 1992 and to 18 percent in 1993. To correct for fiscal drag, the new tax legislation establishes that, in future, income tax brackets will be revised in line with inflation. This contrasts with past practices, when income tax brackets were adjusted in an ad hoc manner.
Finally, to address several social issues, the reform expands specific tax deductions. Allowance is made for larger deductions for child-care expenses (deducciones por guardería), care for the handicapped (minusválidos), dependency allowances, etc.
Taxation of Capital Income
The reform targets a more unified tax treatment of investments in financial and real assets (mainly housing) and a more lenient treatment of capital income earned by nonresidents. It also introduces a tax-exempt system of “popular savings” (hucha fiscal).
Hitherto, the Spanish tax system has discriminated against private sector investments in financial assets. By contrast, investment in housing received a more favorable tax treatment due to tax deductions of interest payments on mortgage loans, tax incentives for investments in a second house, and the utilization of rather obsolete taxable property values. This situation brought about tax fraud in the filing of capital income from financial investments and a proliferation of financial products, such as single-premium insurance bonds (Primas Unicas) with spurious financial characteristics to avoid taxation. Also, there was a rapid increase in speculative investment in housing.
To address these problems, the reform simplifies the system of capital taxation. First, a minimum exemption, common to different types of capital income (interest income or dividends), has been established.3 Second, taxation of undistributed profits of private investment funds has been harmonized with that existing in other EC countries. In particular, the new legislation exempts investors from all withholding taxes on undistributed profits earned in the fund and only applies the capital gains tax when the resources are drawn from the fund. Third, interest deductibility on second-house mortgage loans has been reduced. Fourth, the reform modifies prorating practices of capital losses against capital gains.4 In general, long-term capital gains are now tax exempt.
On the tax treatment of capital income of nonresidents, the reform takes a liberal approach. For the case of residents of any other EC country that is not a “fiscal paradise,” the reform eliminates the payment of withholding taxes on interest income and taxes on capital gains resulting from the purchase and sale of financial assets issued in Spain. This tax exemption, however, does not include dividends accrued to non-resident EC investors (this is in line with current practices in other EC countries, see Table 15). In the case of investors who are residents of third countries (non-EC countries), tax exemptions will be decided in line with bilateral agreements.
Capital Income Taxation in the EC as of March 1990 1
(Tax rates in Percent)
W indicates withholding; FW, final withholding.
Proposed in White Paper of 1989.
Effective withholding through “advanced corporation tax” (ACT).
Capital Income Taxation in the EC as of March 1990 1
(Tax rates in Percent)
| Dividends | Interest on Bonds | Interest on Public Bonds | Interest on Bank Deposits | ||
|---|---|---|---|---|---|
| Spain | |||||
| Resident | 25 W | 20–45 W | 0–25 W | 25 W | |
| Nonresident2 | 25 FW | No W | No W | No W | |
| Belgium | |||||
| Resident | 25 W | 25 W | 0–25 W | Max. 25 W | |
| Nonresident | 25 FW | 25 FW | 0–25 FW | 0–25 FW | |
| Denmark | |||||
| Resident | 30 W | No W—Income tax | No W—Income tax | No W—Income tax | |
| Nonresident | 30 FW | — | — | — | |
| France | |||||
| Resident | No W—Income tax | 26–51 W | Various rates W | Optional W | |
| Nonresident | 25 FW | 25 FW | 25 FW | - | |
| Germany | |||||
| Resident | 25 W | No W—Income | No W—Income | I0W | |
| Nonresident | 25 W | 25 W | No W | I0W | |
| Greece | |||||
| Resident | 42–45 W | 25 W | — | — | |
| Nonresident | 25 W | 25 W | No W | No W | |
| Ireland | |||||
| Resident | 35 W 3 | 35 W | No W | No W | |
| Nonresident | No W | 35 W | 35 W | No W | |
| Italy | |||||
| Resident | I0W | 12.5 FW | 12.5 FW | 25–30 FW | |
| Nonresident | 32.4 FW | I2.5FW | 12.5 FW | 25–30 FW | |
| Luxembourg | |||||
| Resident | I5W | No W | No W | No W | |
| Nonresident | I5W | No W | No W | No W | |
| Netherlands | |||||
| Resident | 25 W | No W | No W | No W | |
| Nonresident | 25 FW | — | — | — | |
| Portugal | |||||
| Resident | 25 W | 25 W | — | 20 W | |
| (FW at taxpayer’s option) | (FW at taxpayer’s option) | (FW at taxpayer’s option) | |||
| Nonresident | 25 FW | 25 FW | — | 25 FW | |
| United Kingdom | |||||
| Resident | 25 W3 | 25 W | 25 W | Variable | |
| Nonresident | 15–25W | 25 W | 25 W | No W | |
W indicates withholding; FW, final withholding.
Proposed in White Paper of 1989.
Effective withholding through “advanced corporation tax” (ACT).
Capital Income Taxation in the EC as of March 1990 1
(Tax rates in Percent)
| Dividends | Interest on Bonds | Interest on Public Bonds | Interest on Bank Deposits | ||
|---|---|---|---|---|---|
| Spain | |||||
| Resident | 25 W | 20–45 W | 0–25 W | 25 W | |
| Nonresident2 | 25 FW | No W | No W | No W | |
| Belgium | |||||
| Resident | 25 W | 25 W | 0–25 W | Max. 25 W | |
| Nonresident | 25 FW | 25 FW | 0–25 FW | 0–25 FW | |
| Denmark | |||||
| Resident | 30 W | No W—Income tax | No W—Income tax | No W—Income tax | |
| Nonresident | 30 FW | — | — | — | |
| France | |||||
| Resident | No W—Income tax | 26–51 W | Various rates W | Optional W | |
| Nonresident | 25 FW | 25 FW | 25 FW | - | |
| Germany | |||||
| Resident | 25 W | No W—Income | No W—Income | I0W | |
| Nonresident | 25 W | 25 W | No W | I0W | |
| Greece | |||||
| Resident | 42–45 W | 25 W | — | — | |
| Nonresident | 25 W | 25 W | No W | No W | |
| Ireland | |||||
| Resident | 35 W 3 | 35 W | No W | No W | |
| Nonresident | No W | 35 W | 35 W | No W | |
| Italy | |||||
| Resident | I0W | 12.5 FW | 12.5 FW | 25–30 FW | |
| Nonresident | 32.4 FW | I2.5FW | 12.5 FW | 25–30 FW | |
| Luxembourg | |||||
| Resident | I5W | No W | No W | No W | |
| Nonresident | I5W | No W | No W | No W | |
| Netherlands | |||||
| Resident | 25 W | No W | No W | No W | |
| Nonresident | 25 FW | — | — | — | |
| Portugal | |||||
| Resident | 25 W | 25 W | — | 20 W | |
| (FW at taxpayer’s option) | (FW at taxpayer’s option) | (FW at taxpayer’s option) | |||
| Nonresident | 25 FW | 25 FW | — | 25 FW | |
| United Kingdom | |||||
| Resident | 25 W3 | 25 W | 25 W | Variable | |
| Nonresident | 15–25W | 25 W | 25 W | No W | |
W indicates withholding; FW, final withholding.
Proposed in White Paper of 1989.
Effective withholding through “advanced corporation tax” (ACT).
Finally, the reform also provides incentives to the small saver. It recommends the introduction of a five-year “popular savings plan” in insurance bonds or government securities where all interest income would be tax exempt. The maximum investment in this plan would be Ptas 1 million a year and Ptas 10 million during five years. Each year, the investor would be allowed to draw his tax-free interest income from the plan. Should he decide to draw his capital before the five years, he would have to pay all past tax liabilities on the interest earned.
Issues in the Spanish Tax Reform
During the last fifteen years, a large number of industrial countries have reformed their tax systems. The objectives of these reforms have not been unique and, in some cases, were not attained. In other cases, tax changes gave rise to unforeseen consequences, complicating the implementation of financial policies and requiring additional changes in the tax system.
Most recent tax reforms have been comprehensive. They have covered both direct and indirect taxation or, at least, a rather broad array of direct taxes, including both personal and corporate income taxes. Experience has shown that it is rather difficult to obtain significant results by partially reforming a limited number of taxes given the tight connection between the activities of the economic agents in their various capacities and their ability to transform the legal character of these activities without affecting their economic content. On these grounds, it could be argued that the Spanish reform is somewhat incomplete. It reforms individual income taxes but leaves unchanged corporate income taxation. This is of particular relevance given the proliferation of tax exemptions and deductions lowering the effective rates of corporate taxation. Low rates of corporate taxation have been an incentive for some individuals to establish companies for tax purposes. Also, the lack of integration of the corporate tax with the individual income tax has resulted in distortions, such as the double taxation of dividends (as profits and as individuals’ income).
Recent tax reforms have given limited attention to the level of private savings due to the lack of clear evidence on how to use specific tax instruments to alter the savings rate. Instead, reforms have concentrated more on the efficient allocation of private savings and investments. Of particular interest in this context is the inclination of governments to adopt special provisions to promote particular types of saving and to permit individuals to shelter from taxation some selected categories of income. This type of preferential treatment has been introduced in tax laws, including tax reforms, mainly in two categories: saving related to retirement pensions and “small-scale” saving.5 The same applies, in the Spanish reform, to the popular savings plan described above. The general question that arises is whether incentives for particular types of saving increase total savings or simply change the composition of existing savings. Fiscal experts have strongly maintained that selective preferential provisions have only provided unwarranted tax benefits and windfall gains to savings that would have occurred anyway. These provisions have channeled savings into assets yielding the highest after-tax returns, which are not necessarily those that yield the highest before-tax returns. In general, when faced with an array of assets with different degrees of preferential taxation, individuals would shift assets from the less to the most tax-favored activities and equilibrium would be achieved when the after-tax returns are the same in all activities. As a result of this process, savings are allocated to un-productive uses and the productivity gains from investment are reduced. In view of these considerations, it would seem advisable that savings schemes such as the Spanish popular savings plan ought to be reviewed.
All things considered, it still remains largely true that the most direct way to increase total national saving, and not merely private saving, is through public saving. Therefore, the current Spanish tax reform will have to be revenue neutral to prevent an increase in the public sector deficit. In this context, it seems unavoidable that (1) the cuts in top marginal rates required on grounds of efficiency, (2) the EC-determined need to reduce capital income taxation, (3) the special treatment given to low-income wage earners, and (4) the introduction of a popular savings plan will require a discussion of adjustments in other revenue instruments. These instruments include indirect taxes, a review of the effective corporate income tax with the aim of reducing tax expenditures, and a strengthening of the tax enforcement mechanisms in order to reduce tax evasion.
The transitory system continued to provide only one rate schedule, applicable both to the individuals and family units, but, while members of the family unit might continue to file joint returns under a slightly modified version of the 1978 system, it also allowed the filing of separate returns. The election to file joint returns was made somewhat more attractive through the introduction of a new tax credit for joint filers and the increase in the existing tax credit for twoincome families.
All capital income exceeding this minimum would be taxed at investor’s marginal income tax rate.
The prorating of capital gains (losses) is called for to avoid the “bunching” problem that occurs when large capital gains (losses), which are accumulated over many years, are realized in a single year.
For example, France has recently raised the tax-exempt ceiling on savings accounts, while tax preferences were also increased in the area of housing. Sweden has exempted some type of savings accounts, and the United Kingdom has introduced new schemes to encourage “noninstitutional savings.” These schemes include the personal equity plan that permits limited investment in quoted shares, which are exempt from capital gains tax or tax on reinvested dividends.
